XTI Aerospace, Inc. 10-Q

Item 1A. Risk Factors We face a number of significant risks and uncertainties in connection with our operations. Our business, results of operations and financial condition could be materially adversely affected by these risks. Except as disclosed below, there have been no material changes to the Risk Factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2019. 52 Risks Related to our Operations The effects of the COVID-19 pandemic could adversely affect our business, operations, financial condition and results of operations, and the extent to which the effects of the pandemic will impact our business, operations, financial condition and results of operations remains uncertain. The United States and the global community we serve are facing unprecedented challenges posed by the COVID-19 pandemic. The pandemic, and the preventative measures taken in response (including “shelter-in-place” or “stay-at-home” and similar orders issued by international, federal, state or local authorities), have resulted in, and are expected to continue to result in, significant volatility and business and economic disruptions and uncertainty. We have taken steps to protect our employees and we continue to operate all of our services, but the extent to which the effects of the pandemic will impact our business, operations, financial condition and results of operations is uncertain, rapidly changing and hard to predict and will depend on numerous evolving factors that we may not be able to control or predict, including: ● the duration and scope of the pandemic; ● the extent and effectiveness of responsive actions by authorities and the impact of these and other factors on our employees, customers and vendors; ● the impact of the pandemic on our employees, including key personnel; ● the extent to which we are able to maintain and replace critical internet infrastructure components, when necessary; ● any disruption of our supply chain and the impact of such disruptions on our suppliers or our ability to deliver products and services to our customers; ● our continued ability to execute on business continuity plans for the maintenance of our critical internet infrastructure, while most of our employees continue to work remotely; and ● any negative impact on the demand for our services and products resulting from the economic disruption caused by the pandemic and responses thereto. If we are unable to successfully respond to and manage the impact of the pandemic, and the resulting responses to it, our business, operations, financial condition and results of operations could be adversely impacted. We have a significant amount of debt outstanding. Such indebtedness, along with the other contractual commitments of our Company, could adversely affect our business, financial condition and results of operations. As of June 30, 2020, we have an aggregate outstanding principal and accrued interest balance of approximately $6.7 million underlying the promissory note issued to Iliad Research and Trading, L.P. (“Iliad”). This promissory note matures in March 2021. In addition, Iliad may, subject to current standstill agreements, require us to redeem 1/3 of the initial principal balance of their promissory notes each month in cash. The ability to meet payment and other obligations under this note depends on our ability to generate significant cash flow in the future. This, to some extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors beyond our control as described in this Form 10-Q. If we are not able to generate sufficient cash flow to service our debt obligations, we may need to refinance or restructure debt, exchange debt for other securities, sell assets, reduce or delay capital investments, or seek to raise additional capital. If we are unable to implement one or more of these alternatives, we may not be able to meet debt payment and other obligations, which could have a material adverse effect on our financial condition. In addition, so long as the note is outstanding, the holder will have a right of first refusal on more favorable equity-linked financings and will be entitled to participate in certain equity or debt financings, in each case, subject to certain exceptions. The existence of these rights may deter potential financing sources and may lead to delays in our ability to close proposed financings. Any delay or inability to complete a financing when needed could have a material adverse effect on our financial condition. We may also incur additional indebtedness in the future. If new debt or other liabilities are added to our current consolidated debt levels, the related risks that we now face could intensify. We identified a material weakness in our internal control over financial reporting for the year ended December 31, 2019 and may identify additional material weaknesses in the future or otherwise fail to maintain an effective system of internal controls, which may result in material misstatements of our financial statements or could have a material adverse effect on our business and trading price of our securities. We are subject to the reporting requirements of the Exchange Act, the Sarbanes-Oxley Act and the rules and regulations of the Nasdaq Capital Market. Pursuant to Section 404 of the Sarbanes-Oxley Act, we are required to perform system and process evaluation and testing of our internal control over financial reporting to allow our management to report on the effectiveness of our internal control over financial reporting. In connection with the audit of our consolidated financial statements as of and for the year ended December 31, 2019, we identified a material weakness in our internal control over financial reporting. A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our consolidated financial statements will not be prevented or detected on a timely basis. The material weakness resulted from a determination following initial audit procedures that the documentation underlying the preparation of forward projections which included copies of customer contracts underlying the basis of projecting revenues and support for the projected cost structures associated with determining the fair value of the Sysorex note as of December 31, 2019 was not supportable thereby requiring material adjustments to be made to the carrying value of the note as determined by management as of December 31, 2019. 53 To address the material weakness, during February 2020, we enhanced our internal technical accounting capabilities by engaging and using third-party advisors to assist in areas requiring specialized technical accounting expertise, including with respect to designing the procedures and processes associated with assessing the fair value of our equity and debt instruments. We have remediated this material weakness during the quarter ended June 30, 2020. Additionally, with each prospective acquisition we may make we will conduct whatever due diligence is necessary or prudent to assure us that the acquisition target can comply with the internal controls requirements of the Sarbanes-Oxley Act. Notwithstanding our diligence, certain internal controls deficiencies may not be detected. As a result, any internal control deficiencies may adversely affect our financial condition, results of operations and access to capital. We have not performed an in-depth analysis to determine if historical undiscovered failures of internal controls exist and may in the future discover areas of our internal controls that need improvement. We cannot assure you that the measures we have taken to date, together with any measures we may take in the future, will be sufficient to avoid potential future material weaknesses. If we are unable to successfully remediate any future material weakness in our internal control over financial reporting, or if we identify any additional material weaknesses, the accuracy and timing of our financial reporting may be adversely affected. If we are unable to maintain effective internal controls, we may not have adequate, accurate or timely financial information, and we may be unable to meet our reporting obligations as a public company, including the requirements of the Sarbanes-Oxley Act. Failure to comply with the Sarbanes-Oxley Act, when and as applicable, could also potentially subject us to sanctions or investigations by the SEC or other regulatory authorities. Any failure to maintain or implement required new or improved controls, or any difficulties we encounter in their implementation, could result in identification of additional material weaknesses or significant deficiencies, cause us to fail to meet our reporting obligations or result in material misstatements in our financial statements. Furthermore, if we cannot provide reliable financial reports or prevent fraud, our business and results of operations could be harmed and investors could lose confidence in our reported financial information. Domestic and foreign government regulation and enforcement of data practices and data tracking technologies is expansive, broadly defined and rapidly evolving. Such regulation could directly restrict portions of our business or indirectly affect our business by constraining our customers’ use of our technology and services or limiting the growth of our markets. Federal, state, municipal and/or foreign governments and agencies have adopted and could in the future adopt, modify, apply or enforce laws, policies, and regulations covering user privacy, data security, technologies that are used to collect, store and/or process data, and/or the collection, use, processing, transfer, storage and/or disclosure of data associated with individuals. The categories of data regulated under these laws vary widely, are often broadly defined, and subject to new applications or interpretation by regulators. The uncertainty and inconsistency among these laws, coupled with a lack of guidance as to how these laws will be applied to current and emerging indoor positioning analytics technologies, creates a risk that regulators, lawmakers or other third parties, such as potential plaintiffs, may assert claims, pursue investigations or audits, or engage in civil or criminal enforcement. These actions could limit the market for our services and technologies or impose burdensome requirements on our services and/or customers’ use of our services, thereby rendering our business unprofitable. Risks Related to the Systat License Grant We may not be able to successfully integrate the License Grant, or retain the existing customer base, which may result in our inability to fully realize the intended benefits of the Systat transactions. In addition the integration of the sale of these software products into our business operation may disrupt our current operations, which could have a material adverse effect on our business, financial position and/or results of operations. During the second quarter, we acquired the license to use, modify, develop, market and distribute certain software owned or licensed by the Systat Parties. Incorporating the marketing and distribution of this software on a worldwide basis into our operations may result in operational, technological and personnel-related challenges, which are time-consuming and expensive and may disrupt our ongoing business operations. Furthermore, integration involves a number of risks, including, but not limited to: · difficulties or complications in combining the acquired technologies, equipment and personnel into our operations; · differences in controls, procedures and policies, regulatory standards and business cultures between the acquired personnel and our current personnel; · the diversion of management’s attention from our ongoing core business operations; · the potential loss of key personnel; · the potential loss of key customers or suppliers who choose not to do business with us; · difficulties or delays in consolidating the acquired technologies; and/or · unanticipated costs and other assumed contingent liabilities. These factors could cause us to not fully realize the anticipated financial and/or strategic benefits of the transactions, which could have a material adverse effect on our business, financial condition and/or results of operations. 54 Several of our directors may be deemed to be interested parties in the transactions by virtue of their relationships with Sysorex, Cranes, or Systat. These interrelationships may create, or appear to create, conflicts of interest. Nadir Ali, our chief executive officer and director, is also a director of Sysorex, the issuer of the Sysorex Note that was assigned as consideration for the transactions. Mr. Ali’s dual roles may create conflicts of interest between Mr. Ali’s obligations to our company and its shareholders and his obligations to Sysorex and its shareholders. For example, Mr. Ali may be in a position to influence whether Sysorex complies with its obligations under the note purchase agreement pursuant to which the promissory note was issued, and whether we lend additional amounts to Sysorex, waive defaults or accelerate such indebtedness or take other steps as a secured creditor in a manner that may be viewed as contrary to the best interests of either our company or Sysorex and their respective stockholders. Any such decision may also affect Systat the holder of a substantial portion of the indebtedness under the note purchase agreement. There is substantial risk that Cranes may be forced into involuntary bankruptcy or receivership because it is defending several petitions from creditors seeking to wind-up its business, it is subject to considerable potential fines from Indian regulators, and owes significant amounts in taxes to Indian tax authorities. Should Cranes be forced into bankruptcy or receivership, Cranes would likely reduce or discontinue its operations, and its assets and those of its subsidiaries could be sold to the benefit of creditors or to satisfy statutory amounts due to Indian authorities and regulators. Creditors of Cranes and Indian authorities may also seek to, in some circumstances, terminate, unwind or void, licensing agreements between Cranes and other entities, including its subsidiaries,. Should Cranes be forced into bankruptcy or receivership, our rights and remedies under the License Agreement may be impaired or inadequate, including our ability to purchase the software licensed thereunder. The bankruptcy of Cranes would only affect us to the extent that it affects the License Agreement, and the indemnification obligations thereunder, or the License Grant. For example, creditors of Cranes or Indian authorities could seek to withdraw authorization or otherwise void the License Agreement, in whole or in part, between us and Cranes, thereby depriving us of the intellectual property licenses thereunder. If we are unable to remedy the situation under the applicable circumstances, such an event would cause substantial harm to our business and any of our operations to the extent that they rely on or are structured around such licensed intellectual property. We may not realize the full benefit of the License Grant if the licensed material has less market appeal than expected. In addition to designing and developing our own products and services, we evaluate various strategic transactions and acquisitions of companies with technologies and intellectual property that complement our products and services by adding technology, differentiation, customers and/or revenue. We believe these complementary technologies will add value to the Company and allow us to provide a comprehensive indoor intelligence platform, offering a one-stop shop to our customers. We anticipate that the License Grant will result in an increase in our revenues; however, there can be no assurance that we will be able to retain the existing customer base or expand the technologies and products licensed from Systat with existing customers and finding new customers to sell our products and services to. This may require increasingly sophisticated and costly sales efforts and may not result in additional sales. In addition, the rate at which our customers purchase additional products and services, and our ability to attract new customers, depends on a number of factors, including the perceived need for indoor mapping products and services, as well as general economic conditions. If our efforts to sell additional products and services are not successful, our business may suffer. If we fail to comply with our obligations in our intellectual property licenses, we could lose license rights that may important to our business and results of operations. The License Agreement imposes certain obligations on us. If we fail to comply with the terms and obligations of the License Agreement, including the obligation to assign a portion of our right to repayment from the Sysorex Note in accordance with the schedule set forth in the License Agreement, our rights may be reduced or terminated, in which event we may not be able to develop and market any product that is covered by the License Grant. Termination of the License Grant for failure to comply with such obligations or for other reasons, or reduction or elimination of our licensed rights under it, may result in our having to negotiate new or reinstated licenses on less favorable terms or cause us to enter into a new license for a similar intellectual property. The occurrence of such events could materially harm our business and financial condition. If we do not adequately protect our intellectual property rights received in connection with the License Agreement, we may experience a loss of revenue and our operations and growth prospects may be materially harmed. The Systat Parties have represented to us that the licensed intellectual property is legally and beneficially owned or licensed by the Systat Parties. Although we are not aware of any infringement claims, it is possible that such claims are made during the Term. While the Systat Parties have agreed to indemnify us in connection with any losses or claims relating to any infringement of the licensed intellectual property, any loss of the intellectual property rights could result in a loss of revenue and our operations and growth prospects may be materially harmed. 55